Milan (AsiaNews) – After the crises in subprime lending, the banking sector and the stock market, the same tsunami is sending a new tidal wave that could crash against the dollar and the Euro but also against China and Asia, Eastern Europe as well other emerging nations.
This view does not fit well with the agreement reached in Washington by G-20 heads of government and heads of state whose countries represent almost 90 per cent (1) of the world Gross Domestic Product (GDP). In the US capital the leaders of these countries pledged not to erect new trade barriers. In their view globalisation must not stop; we should not return to protectionism, making the same error made in the 1929 crisis. However, such a unanimous consensus seems more lips service to an idea than any actual meeting of the minds. In reality the development of globalisation has been based on an unbalanced economic model. Until now it has relied on controlling monetary emission and non tariff barrier protectionism. The coming monetary storm will thus be a violent and dangerous rebalancing act of the system of international exchange.
Many countries, especially the United States, have printed more money in order to cope with the crisis. Solvency, not liquidity is at the root of the current economic turmoil. Flooding the system with debt liquidity will exacerbate the problem, not solve it. In a short period of time the US Federal Reserve and the US Treasury Department are raking up a mammoth level of debt for US taxpayers—US$ 7,740 billion according to Bloomberg (2), 11 times what was in Secretary Paulson’s original plan, or 56,19 per cent of the US GDP in 2007. It is not even clear whether this is legal, but one can wonder whether it is fair not only to the American people but also towards the rest of the World, especially to Asian countries which are among the major holders of wealth in US dollars.
An unbalanced economic model
Globalisation is based on an unbalanced economic model. So far public and private consumption in the United States have driven world demand. US consumers made export-driven growth in many countries possible. The absurdity of this method lies in the fact that producers get underpaid and are forced into saving in order to provide credit for those who do not produce and could hardly afford to buy. Workers in China, Brazil and India get starvation wages to produce goods tailored-made for the US (and Western) market (3) whilst US consumers are unable to generate corresponding resources and value. In fact, the trend for the US GDP is negative since the third quarter of 2000 when calculated on the basis of inflation as calculated prior to the Clinton era (4). Yet US consumers have been pushed, flattered and funded to live above their means, almost forced to buy every kind of goods. This is why there is a solvency problem.
Two factors are at the basis of this absurdity: available financial liquidity and accumulation of monetary reserves. On the one hand, US monetary authorities had agreed to an extraordinary increase in financial bank money supply, the so-called M3. Too much of this, even in the form of large or medium term securities, reduces its real value. It should have led to the devaluation of the dollar, but instead, the monetary mass in dollars as a means of payment was maintained an unchanged worth, especially in Asia and emerging countries. This was possible by the role of the dollar, which was boosted by the collapse of the Soviet Union, as the world’s reserve currency as well as by deliberate policies of the Federal Reserve and the US Treasury Department. Thanks to a series of financial engineering instruments made possible by the abolition of the Glass-Steagall law in 1999 like ABSs, CDSs, interest rate forward contracts, securities in US dollars were declared to be “secure”. Credit rating agencies rated these securities as safe (like those of Lehman Brothers for example), giving them the famous AAA or Triple-A grade. This way debt by private institutions could be treated like currency, at face value, and could be registered as balance sheet without the need to set aside reserves for any risk. Similarly greatly underestimating the exchange rate of some emerging economies, especially China’s, in terms of purchasing power parity resulted in what is an actual subsidy to their exports with the effect that their take-off was far greater than their capacity to guarantee quality, delivery, service, sale network, etc.
Rapidly, the monetary reserves of countries like China, Brazil, India and Russia, not to mention oil exporters, shot up quickly to the benefit of local oligarchies. At this juncture an absurd situation turnes into a tragic one as the international system becomes more unstable. In fact since most people in emerging countries are paid in local currencies, they are denied the benefits brought by higher currency reserves. In China alone this means some 900 million people. The consumptions priorities of by local oligarchies are quite different from those of the rest of the population. Not only can the former expand their ideological or religious influence, but they can also push their countries into a military build-up (conventional and nuclear), raise national prestige (space exploration), and buy luxury items and so on. This could have meant that people in emerging nations might get more food supplied by countries like the United States, Canada, Australia and even the European Union that are rich in water and farmland. Higher food consumption in emerging economies could have balanced capital flows. Instead artificially low exchange rates for emerging nations’ currencies, especially China, pushed up the cost of food. (5) This, in turn, raised domestic tensions to which local ruling oligarchies reacted by re-directing attention externally.
In some countries and under some historical circumstances, export-driven expansion can go hand in hand with a stable system as long as monetary circulation is not distorted. Above all this can happen if the solvency of the system is not jeopardised.(6) But under present circumstances, this risk is high because certain levees have been breached.
A first parameter of instability is the gross US foreign debt, which rose from US$ 6,946 trillion as of 31 December 2003 to US$ 13.427 trillion as of 31 December 2007.(7) This is internationally circulated currency. As of the end of last year it was almost equal to 100 per cent of the US GDP (8). Even though it doubled in a just a few short years, the US economy is not big enough to continue to provide sovereign debt (as monetary reserve currency) in accordance with the growth needs of the world economy.
A second parameter is the staggering rate of growth of the total public debt of the United States. Until 31 December last year, the US public debt stood at US$ 10.6 trillion or 76.75 per cent of GDP. Adding the Paulson plan and the rescue package for Fannie Mae and Freddie Mac (but not counting that of AIG), the ratio jumped to 118.02 per cent.(9)
If the these figures published by Bloomberg are correct—US$ 7.74 trillion in rescue packages—we arrive at about US$ 23.3 trillion of public debt for a ratio of 169 per cent of GDP. In just a short period of time the public debt of the United States almost doubled or tripled. Whatever the case may be, it is by far too high.
Although important, these parameters are not decisive. A study by the International Monetary Fund (IMF) (10) found that when the foreign-owned public debt of a country reaches 60 per cent of the GDP that country is in dangerous territory and risks a major monetary crisis. Similarly, other circumstances—a high current government deficit (11) and a negative trade balance—contribute to this kind of risk. At present, all of them come together in the United States.
A crucial point is the high percentage of public debt held by foreign investors. For many years after the Second World War the United States was a net creditor to the rest of the world. Since 1987 that is no longer the case. What proportion of the US public debt is held by non-resident foreigners after the United States adopted a number of rescue packages this fall remains unclear. The latest available official figures show that at the end last year the ratio between gross foreign debt and net claims of foreigners on the United States (Table 13-5 of the US Government budget for the 2009 Fiscal Year) stood at 61.82 per cent, (12) up from 54.42 per cent in the previous year. It is probable that this year it rose even further. But let us assume that it was the same as that of 2007. Even on the basis of the first number (118.02 per cent of the public debt with respect to the GDP), the threshold indicated by the aforementioned IMF study has been crossed (the ratio is about 73 per cent of the US GDP).
One thing must be made clear. The IMF study obviously referred to emerging economies whose currencies unlike the US dollar are not reserve currencies.(13) It is therefore impossible to determine with any certainty what the level is in the current US case. We can none the less roughly assume that a breaking point is quickly coming up because if we add up US public debt and spending commitment in health case (Medicaid and Medicare) and pensions (social security) we get to 429,27 per cent of GDP.(14)
Last but not least let us not forget that in 2007 Asian investors, especially Japanese and Chinese, were the main foreign investors in US financial assets.
China and the devaluation of the yuan
For years AsiaNews has been focusing on another danger, namely the highly and arbitrarily undervalued currencies of many emerging economies. In the case of China the currency is undervalued by 55.54 per cent. In practice this has enabled China to maintain the devaluation it carried out on 1 January 1994 when it set the yuan (CNY) or renminbi (RMB) at 8.62 against the US dollar when it unified the two different exchanges rates that existed at the time. Devaluation gave China an opportunity to create favourable conditions for itself before it had to drop custom duties to join the World Trade Organisation (WTO).
Currently, because the exchange rate is controlled by the People’s Bank of China, the US dollar is worth about 6.8798 CNY. A simple calculation using 2007 World Bank data can show how much the yuan is undervalued. At the current exchange rate China’s GDP stands at US$ 3.280 trillion. But if that same data is expressed in terms of Purchasing Power Parity (PPP), it rises to US$ 7.055 trillion. What this means is that the real exchange rate should be quite different were it to express the same purchasing power. In fact if we applied the same relationship between China’s GDP in current dollars (6.04 per cent of world GDP) and China’s GDP at purchasing power parity (which is 10.78 per cent of World GDP), a US dollar should be exchanged at 3.821 yuan (hence the latter is undervalued by 55.54 per cent).
At such an exchange rate however, Chinese exports would collapse and most Chinese factories would have to shut down and lay off workers. This would cause social upheavals and threaten the country’s ruling class. Seen as the world’s workshop, China is a great success, but if we consider the amount of human resources, capital and raw materials used with regards to GDP growth per unit then its system of production appears very inefficient. What is more, China’s yuan devaluation in 1994 led right to the 1998 Asian crisis. For Asia that crisis was the price to pay for China’s transition from Communism to a market economy, the equivalent in some ways of the collapse of the 1989 Berlin Wall. Ten years later economic history seems to be repeating itself, many times over.
For its transition out of Communism China has adopted an export-driven development model. As economic history shows, this model lacks internal balance as we are now realising. At present it has led to a mad dash for industrial delocalisation and is a contributing cause of the world’s current financial meltdown. If it goes on any further it runs the risk of provoking an unprecedented monetary crisis with a brutal re-adjustment of the system. So far the model has survived because it has served the interests of those in power, of those who control the purse (the US Federal reserve and to a lesser extent the European Central Bank), manpower (China’s Communist Party for example) and raw materials (Gulf sheiks and Russia’s ruling oligarchy, etc.).
Also the decisions made by the G-20 in Washington to lay the grounds for a new world monetary system in order to save globalisation can serve the transnational oligarchy. Controlling the instruments of payment is the basis of power.
Today an attempt is underway to create on the ashes of the dollar a new de facto world central bank, or perhaps a new Euro-American currency, or perhaps only a North American currency, the Amero. We don’t know. This may be good for the World Bank, the World Trade Organisation, the International Monetary Fund, the Financial Stability Forum, and the various United Nations agencies, the people in charge of the US Federal Reserve, the European Central Bank, the People’s Bank of China, and other central banks. It is not clear whether it is good for the rest of the world.
1. Michael McKee and Simon Kennedy, “G-20 Calls for Action on Growth, Overhaul of Financial Rules,” in Bloomberg News, 16 November 2008.
2. Author’s calculation based on World Bank data for the Gross Domestic Product (GDP) and debt. Other sources say US$ 8,500 billion. See “U.S. Pledges Top .7 Trillion to Ease Frozen Credit,” by Mark Pittman and Bob Ivry, in Bloomberg News, 24 November 2008.
3. Private savings by Chinese workers are a must because of the lack of proper social welfare support (pensions, unemployment insure, public health care, etc.). In a context where companies’ bottom lines were not very accurate, to say the least, small investors who put their money in stocks saw their savings wiped out. At the beginning bull markets profited those with inside information; eventually shares lost much more value than other financial products. See “Chinese stocks and the risk of economic crisis,” by Maurizio d’Orlando, in AsiaNews, 22 May 2007. Although people have been forced to save, a situation that has the effect of reducing domestic consumption, they have not been able to invest, except in state banks. The latter are notorious for always being on the brink of bankruptcy and for investing depositors’ savings according to political criteria or turning them over to China’s central bank for investments in Treasury bills and other financial activities in dollars.
4. See John Williams’ Shadow Government Statistics, “Inflation, Money Supply, GDP, Unemployment and the Dollar - Alternate Data Series,” 19 November 2008.
5. See “Food prices reach alarming levels,” by Maurizio d’Orlando, in AsiaNews, 9 August 2008.
6. The precedent of Imperial Germany does not bode well because the demand for raw materials that followed the flooding of world markets by ‘Made in Germany’ goods was one of the causes of the outbreak of war in 1914.
7. US Treasury data. The amount stood at US$ 9.476 trillion as of 31 December 2005.
8. See US Treasury data in http://www.treasury.gov/tic/debtad03.html, http://www.treasury.gov/tic/deb2ad07.html and http://www.treasury.gov/tic/deb2ad05.html
9. Author’s calculation based on World Bank and US Treasury Department data.
10. This is an estimate. See “Depth of the abyss of economic, social, political chaos,” by Maurizio d'Orlando, in AsiaNews, 30 September 2008. See also IMF, World Economic Outlook, Public Debt in Emerging Markets, September 2003.
11. “World Economic Outlook Public Debt in Emerging Markets,” by the International Monetary Fund, September 2003. The problem obtains in case of poor tax collection (Argentina, India, etc.) and excessive public spending in relation to GDP, which is what is happening to the United States since it put into place various financial rescue plans.
12. US$ 8.3 trillion compared to aforementioned gross foreign debt, US$ 13,427 trillion. See “Analytical Perspectives Budget of the United States Government – Fiscal Year 2009,” by U.S. Government Printing Office, Washington, 2008.
13. There is no precedent for this type of insolvency or public debt moratorium, except in wartimes, by a country whose currency is held as a reserve currency.
14. See footnote 9.